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Interesting Times in the Broad Market

Its been a heck of a run in the market since the March 8th low. Just look at the price chart in the middle – we’ve run up from 666 at the low to 1010 at Friday’s close.

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There are a number of indicators I watch to give me a feel for the direction of the broad market. This graph includes several of them.

Look at the RSI(7) at the top. This is an indicator that, given its position above 70, says the market has gotten ahead of itself. When coupled with the Stochastics reading above 80, we sure have a market that needs to pull back a bit and consolidate the gains we’ve seen. Based upon the other indicators discussed below, though, any pullback will likely be short-lived and seen as a buying opportunity.

In the volume box, you can see that when the market hit a peak in early June and corrected into July, the correction happened on decreasing volume. However, since that correction bottomed out and we’ve rallied to a new recovery high, volume has been increasing. This is a very strong sign that the trend we are in is getting stronger. If you couple that with the Accumulation/Distribution indicator which is in strong uptrend, the market internals are very strong.

The basic premise behind volume indicators, including the Accumulation/Distribution Line, is that volume precedes price. Volume reflects the amount of shares traded in a particular stock, and is a direct reflection of the money flowing into and out of a stock. Many times before a stock advances, there will be period of increased volume just prior to the move. Most volume or money flow indicators are designed to identify early increases in positive or negative volume flow to gain an edge before the price moves.

Two additional price/volume indicators, the Money Flow and On Balance Volume at the bottom of the chart both show that money is flowing into the stock market in a very big way. As long as investors are pouring money into the stock market, any pullback will be muted.

The other two indicators on the chart, the MACD and the ADX are two indicators that direction and strength of the market’s trend. Both are showing us that the trend for the market is decisively up.

If you look at the price graph, you will see a series of horizontal bars. This Price By Volume indicator shows the total volume at various price levels. In general, the larger bars act as support and resistance to price movements. If you look at where the current price is relative to the bars, it is in an area with very little resistance until around 1250 and it shows significant levels of support at 950. You can infer that any downward move in the stock market ought to be contained to the 950 level and there should be a lot of selling pressure ahead until the market gets to the 1250 level.

So, looking at things as objectively as possible, we likely are due for a few percentage point pullback in the broader market as it has moved up too far too fast, but it will be a buying opportunity on the way to 1050, our next target level and 1250 after that (see my older blog posts for how those targets were calculated).

The general uptrend is likely to continue until something fundamental changes the investment landscape. Right now we have excess liquidity that is flowing into the broader stock market. This is pushing up prices as investors are enthused by the positive earnings surprises we’ve seen this quarter. However, there are still significant headwinds that could derail the trend, whether they be further problems in the commercial real estate market, a crisis of confidence in the US Dollar, fears of inflation, a fall back into recession, or something unexpected.

So for now, the trend is your friend. At some point the trend will change, but for now, all indications are that things continue to look up. Any pullback will be viewed as a chance to put cash on hand to work in the investment themes that profit most in the early stages of an economic recovery. If that fundamental change comes about, I’ll let you know here on the blog.

Mark